Chapter 11

Question 1

What is the purpose of chapter 11?

Answer 1

To Describe the state of national economy. Emphasis on description - because the chapter introduces a number of models and pieces of those models to describe the economy

Question 2

What does the Aggregate Demand Model and Aggregate Supply Model describe?

Answer 2

These two models indicate how output, prices, and employment are all tied together as part of a single economic equilibrium

Question 3

Aggregate Demand is equal to.. what?

Answer 3

Aggregate Demand is equal to GDP - C + I + G + M

Question 4

Aggregate Demand Curve Definition

Answer 4

The Aggregate Demand Curve shows the relationship between the overall price level in the economy and output.

Question 5

What are price changes measured by?

Answer 5

the price index or inflation price level

Question 6

How does Consumption affect Aggregate Demand?

Answer 6

Has a negative affect on Aggregate Demand. A rise in overall price leave leaves people to not purchase as much. An increase in price reduces purchasing power; with less Purchasing power, people save more and shifts AD left (GDP shifts left).

Question 7

What is the ‘Wealth Effect’?

Answer 7

Essentially how GDP/ Aggregate Demand curve is affected by consumption
Higher prices, less spending.

Question 8

How does Investment affect Aggregate Demand?

Answer 8

Indirect negative effect between price level and investment spending.
As prices rise, so do interest rates - which make it less appealing for firms to borrow money; rising price results in a decrease in investment spending.

Question 9

How does Government Spending affect Aggregate Demand?

Answer 9

Zero effect on Aggregate demand.
Most government spending is independent of the price level because Gov’ts will always public servants or spend the same on services.

Question 10

How do ‘Net Export’s affect Aggregate Demand?

Answer 10

Negative effect on Aggregate Demand. When Canadian prices increase, Canadian goods become relatively more expensive compared to other country goods.
This increases imports and decreases exports (b/c the world can’t afford us).

Question 11

Why does AD slope downward?

Answer 11

Because 3 of the national expenditure components have a negative relationship with AD.

Question 12

When does the AD curve shift left and right?

Answer 12

When there’s a change in non prices - shifting the factors of production

Question 13

What is the difference between price change and non-price change?

Answer 13

Price changes generate movement ALONG the aggregate demand curve ; Non price changes shift the entire curve left and right.
#Confidence in price levels is a good example of shifting ALONG the curve because this does not actually change output, just price level.

Question 14

Definition of ‘ Aggregate Supply’

Answer 14

Aggregate supply is the sum total of the production of all firms in the economy.
Production occurs when there are more factor inputs - technology, capital, and labour.

Question 15

Definition of ‘Aggregate Supply Curve’

Answer 15

The Aggregate Supply Curve shows the relationship between the overall price level in the economy and toatl production by firms.

Question 16

Two key differences between the Aggregate Supply Curve and Market Supply curve

Answer 16

The Aggregate Supply Curve represents the whole economy.

The Aggregate Supply Curve shows the difference between short term and long term.

Question 17

Key Characteristics of the SRAS Curve

Answer 17

Slope Shifts Upward
Prices Increase More quickly than input prices
increase in final goods lead to revenue for firms
Firms are affected by increasing production

Question 18

Why do prices of final goods in the SRAS shift faster than input prices?

Answer 18

Linked to business cycle, but also idea that due to increased prices, firms will want to increase production short term to ride wave of profits

Question 19

Key Characteristics LRAS Curve

Answer 19

Changes in the price level do NOT affect aggregate supply in long run.
Represents potential output in economy
Only shifts when society experiences something that affects output

Question 20

When is the economy in a boom vs. recession?

Answer 20

the economy is in a boom when its output is more than potential
the economy is in a recession when its less than the potential output.

Question 21

Definition ‘Supply Shock’

Answer 21

Significant events that directly affect production and the AS curve in the short run.
Shifts the SRAS curve left and right

Question 22

What causes the LRAS curve to shift?

Answer 22

Changes input that affect factors of production

Question 23

Do LRAS and SRAS shift together all the time?

Answer 23

Everything that shifts the LRAS shifts SRAS because the available factors of production and technology that determine the position of the LRAS will also drive short run supply.

However, not everything that shifts SRAS shifts LRAS.
Ex) Confidence does not shift LRAS, only SRAS. Firms expect confidence to shift.

Question 24

Where is economic equilibrium?

Answer 24

When Aggregate demand is equal to Aggregate Supply (SRAS and LRAS)

Question 25

How does rightward shift in AD affect the AD-AS model?

Answer 25

• increase in consumer confidence and thus consumption
• shifts along SRAS (price change)
• Short run increase in prices and output (above potential)
• Long run wages and input prices eventually rise (lagging sticky wages catch up eventually) and move up, but brings production back to LRAS
• Output returns to potential output and prices are higher again

Question 26

How does leftward shift in AD affect the AD-AS model?

Answer 26

• decrease in consumer confidence, lower consumption due to wealth effect
• shifts along SRAS (price change drops)
• Lower price change in Consumption
• Firms lower wages and input prices fall
• Since input prices fall, firms produce more
• more production shifts SRAS rightward bringing it back to potential output
• prices are decreased again

Question 27

How does a temporary drop in supply affect SRAS and LRAS?

Answer 27

• Causes SRAS to shift left
• output falls below potential from LR
• Prices increase because producing less
• Shifts ALONG aggregate demand (because the demand has not changed, just the supply)
• with low wages and input prices, firms can produce more and production shifts back to original level
• prices decrease to original level

Question 28

Definition of ‘Stagflation’ and how it relates to ‘Sticky Downward Wages’

Answer 28

Drop in output, Rise in prices due to inflation
Hard to adjust because wages can be dropped by firms to reduce this inflation (lowering input prices reduces consumption and thus price levels), but people are reluctant to accept lower wages.
reluctance in accepting lower wages makes wages sticky.

Question 29

Explain Government Spending to counter negative Demand Shocks in Short Run

Answer 29

With lower demand, AD curve shifts left - thus consumer confidence and consumption - Wealth effect, people are spending less and eventually lower input prices, which causes more production.
Governments can shift the AD curve right by increasing spending.

Question 30

Government Spending to Counter Negative Demand Shocks in Long Run

Answer 30

Demand side shock has no effect on long run. Eventually prices would adjust downward until output rose to its previous level but at a slightly higher price due to government intervention

Question 31

Government Spending to Counter Negative Supply shocks in short run

Answer 31

SRAS has shifted left
economy can be stuck in staglation if no intervention
Gov’t increases spending to shift AD curve
Brings new AD curve back to LR ouput and higher prices because shift along new SRAS

Question 32

Main reason as to why governments would intervene

Answer 32

speed of recovery

lower prices for some but not all (want some prices to be higher)